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Author
D.F. Schrager
A.A.J. Pelsser
Year
2006
Title
Pricing Swaptions and Coupon Bond Options in Affine Term Structure Models
Journal
Mathematical Finance
Volume | Issue number
16 | 4
Pages (from-to)
673-694
Number of pages
22
Document type
Article
Faculty
Faculty of Economics and Business (FEB)
Institute
Amsterdam School of Economics Research Institute (ASE-RI)
Abstract
We propose an approach to find an approximate price of a swaption in affine term structure models. Our approach is based on the derivation of approximate swap rate dynamics in which the volatility of the forward swap rate is itself an affine function of the factors. Hence, we remain in the affine framework and well-known results on transforms and transform inversion can be used to obtain swaption prices in similar fashion to zero bond options (i.e., caplets). The method can easily be generalized to price options on coupon bonds. Computational times compare favorably with other approximation methods. Numerical results on the quality of the approximation are excellent. Our results show that in affine models, analogously to the LIBOR market model, LIBOR and swap rates are driven by approximately the same type of (in this case affine) dynamics.
URL
go to publisher's site
Language
English
Permalink
http://hdl.handle.net/11245/1.271252

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